Decreasing Tax When Selling Investment Property

Added January 25, 2008 by Ilyce R. Glink

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Summary: An investment property owner wants to know if there's a way to sell and pay less tax. He asks about gifting the investment property. A 1031 exchange might be an option for the investment property.

Q: Are there any creative ways to avoid or decrease the tax owed when selling a rental property?

How about giving the home to a family member, then selling it? What are gift tax issues? Can someone receive this gift and sell immediately? Do you have any other ideas?

A: You can't eliminate taxes on real estate investment property. The only way I know to defer tax (meaning, you'll need to pay taxes down the road) is by using a 1031 tax free exchange, also known as a deferred exchange or Starker exchange.

A 1031 tax free exchange allows you to sell your property and defer any taxes owed as long as you buy a replacement investment property that costs at least as much as the property you're selling. There are, of course, many other rules to comply with and you should work with a professional in the area of tax free exchanges.

Giving property to friends or relatives can land you in a heap of tax trouble. You have to file a gift tax form with the IRS and the value of the property counts against your lifetime gift exclusion. In addition, the person you're giving it to gets your future tax liability because they receive the gift at your current cost basis. When they sell, they pay the tax that you would have paid.

The question is, how much do you really owe? If you've held your investment property for at least a year, you'll only pay long-term capital gains tax on the profits, which would top out at 15 percent plus state tax plus you'll have to pay 25 percent of any depreciation that you took while you owned the property. For more details see your tax preparer or accountant.

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